EE More Readings 2014

8/9/2019 EE More Readings 2014

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Example- Application ofBEA


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Example- Application of BEA(Contd.)


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TAX and Economic

Analysis


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Basic Tax Equations -ndividual

!ross ncome ! " salaries # $a%es # interest and

dividends # ot&er income

Taxa'le ncomeT " ! personal exemptions

standard or itemied deductions

TaxT " (taxa'le income)(applica'le tax

rate)


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Before-Tax and After-Tax Cas& *lo$

+C* " cas& in,o$s cas& out,o$s Cas& *lo$ 'efore Tax (C*BT)

C*BT " %ross income expenses initialinvestment # salva%e value

" ! E # Cas& *lo$ After Tax (C*AT)

C*AT " C*BT taxes

Add /epreciation

C*AT " ! E # (! E /)(Te) An evaluation format

ee Ta'le 01 2 and Example 01.2 for acomputational format


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E3ect on Taxes of /i3erent/epreciation 4et&ods and 5ecovery

eriods

Criteria used to compare di3erent depreciationmet&ods compute ---

6'7ective 4inimie t&e 8 of future taxespaid o$in% to a %iven depreciation met&od T&e total taxes paid are equal for all depreciation models

T&e 8 of taxes paid is less for accelerated depreciation

met&ods &orter depreciation periods result in lo$er 8 of future

taxes paid over lon%er time periods

n

tax

t=1

PW = (taxes in year t)(P/F,i,t)


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/epreciation 5ecapture and Capital

!ains (9osses) for Corporations

Capital %ain (C!) C! " sellin% price :rst cost C! "

/epreciation 5ecapture (/5) /5 " sellin% priceyear t 'ook valuetime of sale /5 B;t

Capital 9oss (C9)

C9 " 'ook value sellin% price C9 " B;t-


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/5 ummary - 6utcomes

Zero, $0

Book ValueBV

t

First Cost

P

0

of suc& income tax? provided t&at t&e totalincome exceeds 5s. 0 crore. (4ar%inal 5elief in urc&ar%e? ifapplica'le)

At t&e rate of 0@ of suc& income tax? provided t&at t&e totalincome exceeds 5s. 0@ crores.

"u'atio! Cess 2 of t&e total of ncome Tax and urc&ar%e.


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I!"ia(Contd.)I!'ome Ta% Sla3s 4 Rates for #ssessme!t 5ear 6021

Com)a! other tha! a Domesti' Com)a!

I!'ome Ta%

F >@ of on so muc& of t&e total income as consist of (a) royalties receivedfrom !overnment or an ndian concern in pursuance of an a%reement made'y it $it& t&e !overnment or t&e ndian concern after t&e 20st day of 4arc&?0GH0 'ut 'efore t&e 0st day of April? 0G1HI or (') fees for renderin% tec&nicalservices received from !overnment or an ndian concern in pursuance of ana%reement made 'y it $it& t&e !overnment or t&e ndian concern after t&e

of suc& income tax? provided t&at t&e total income exceeds5s. 0@ crores.

"u'atio! Cess 2 of t&e total of ncome Tax and urc&ar%e.


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I!"ia(Contd.)I!'ome Ta% Sla3s 4 Rates for #ssessme!t 5ear 6021

;ar+i!al Relief = 8&en an assesseeKs taxa'le income exceeds5s. 0 crore? &e is lia'le to pay urc&ar%e at prescri'ed rates

mentioned a'ove on ncome Tax paya'le 'y &im. Lo$ever? t&eamount of ncome Tax and urc&ar%e s&all not increase t&eamount of income tax paya'le on a taxa'le income of 5s. 0crore 'y more t&an t&e amount of increase in taxa'le income.

%am)le

n case of an individual assesseee (M H@ years) &avin% taxa'leincome of 5s. 0?@@?@0?@@@D-

0. ncome Tax 5s.


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I!"ia(Contd.)Value #""e" Ta% 7V#T8=;alue Added Tax (;AT) $as introduced as tax reform to overcome t&e pro'lems

associated $it& prevalent sales tax structure. T&e sales tax structure is

associated $it& t&e pro'lems of dou'le taxation and multiplicity of taxesresultin% in cascadin% tax 'urden. *or instance? in t&e sales tax structure? 'eforea commodity is produced? inputs are :rst taxed? and t&en after t&e commodity is

produced $it& input tax load? output is taxed a%ain. T&is causes an unfair dou'le

taxation $it& cascadin% e3ects. ;AT also a'olis&es multiplicity of taxes liketurnover tax? surc&ar%e on sales tax? additional surc&ar%e? etc.

;alue Added Tax (;AT) is a multi-point system of taxation. Tax is levied on value

addition at eac& sta%e of transaction in t&e productionD distri'ution c&ain. T&eterm Kvalue additionK implies t&e increase in value of %oods and services at eac&

sta%e of production or transfer of %oods and services. ;AT is a tax on t&e :nalconsumption of %oods or services and is ultimately 'orne 'y t&e consumer. ;AT

allo$s Knput tax credit (TC)K for tax paid at earlier sta%e? $&ic& can 'eappropriated a%ainst t&e ;AT lia'ility on su'sequent sale.

T&e desi%n of ;AT $it& input tax credit is 'ased on documentation of tax invoice?cas& memo or 'ill. Every re%istered dealer? &avin% turnover of sales a'ovespeci:ed amount? needs to issue to t&e purc&aser serially num'ered tax invoice

$it& t&e prescri'ed particulars. *or identi:cationD re%istration of dealers under

;AT? t&e Tax ayerKs denti:cation +um'er (T+) is used. T+ consists of 00 di%itnumerals t&rou%&out t&e country. ts :rst t$o c&aracters represent t&e tateCode and t&e set-up of t&e next nine c&aracters can vary in di3erent tates.

I "i l


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I!"ia %am)le

D i i


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De)re'iatio! $@,:/0

738 BV@> 60,000 60,00070.60 0.@6

0.608" $2,-10

Eote alva%e value " U>?@@@ is not used 'y4AC5 and B;H" @

;#CRS Re'o*er Perio"


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;#CRS Re'o*er Perio"Re'o*er )erio" 7!8 is function ofproperty class

T(o sstems for determinin% recovery period=

eral "e)re'iatio! sstem 7GDS8 fastest (riteo& allo(e"

alter!ati*e "e)re'iatio! sstem 7#DS8 lo!+er re'o*er

uses SLIRS )u3li'atio! /1 %ives n values for an asset. *or example= ;#CRS! *alue

#sset "es'ri)tio! GDS #DS ra!+e

pecial manufacturin% devices? race&orses? tractors @@ 2

Computers? oil drillin% equipment? autos? trucks? 'uses 21 .2

6Vce furniture? railroad car? )ro)ert !ot i! a!other 'lass -0 2

+onresidential real property (not land itself) @/0

Qnit-of-roduction (Q6)


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/epreciation/epreciation 'ased on usage of equipment? not

time

/epreciation for year t o'tained 'y relation

/t" (B )

Example= A ne$ mixer is expected to process J million yd2ofconcrete over0@-year life time. /etermine depreciation for year 0 $&en

J@@?@@@ yd2 is processed. Cost of mixer $as U01>?@@@ $it& no

salva%e expected.

olution= /0" (01>?@@@ @) " U01?>@@

a'tual usa+e for eart

e%)e'te" total lifetimeusa+e

/00,000/,000,000


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%am)le Cost a!" Per'e!ta+e


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) +De)letio!A mine purc&ased for U2.> million &as a total expectedyield of one million ounces of silver. /etermine t&edepletion c&ar%e in year J $&en 2@@?@@@ ounces aremined and sold for U2@ per ounce usin% (a) cost depletion?and (') percenta%e depletion. (c) 8&ic& is lar%er for yearJP

Solutio! 9et depletion amounts equal C/AJand /AJ

or? C/J" 2?>@@?@@@D 0?@@@?@@@ " U2.>@ per ounce

CD#/" 2.>@(2@@?@@@) " $,020,000

738 ercenta%e depletion rate for silver mines is @.0>

PD#/" (@.0>)(2@@?@@@)(2@) " $,@20,000

)er'e!ta+e "e)letio! amount? provided it is W >@ of T


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4arket tructures and

Competition


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8LAT A C64ETT;E


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8LAT A C64ETT;E4A5RETP

As a result of its c&aracteristics? t&eperfectly competitive market &as t&efollo$in% outcomes=

T&e actions of any sin%le 'uyer or sellerin t&e market &ave a ne%li%i'le impacton t&e market price.

Eac& 'uyer and seller takes t&e marketprice as %iven.

8LAT A C64ETT;E


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8LAT A C64ETT;E4A5RETP

A competitive market &as many'uyers and sellers tradin% identicalproducts so t&at eac& 'uyer and

seller is a price taker. Buyers and sellers must accept t&e price

determined 'y t&e market.


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T&e 5evenue of a Competitive *irm

Average revenue tells us &o$ muc&revenue a :rm receives for t&etypical unit sold.

Avera%e revenue is total revenuedivided 'y t&e quantity sold.


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n perfect competition?avera%erevenue equals t&e price of t&e %ood.

1 - e r a % e R e - e n ' e = T o t a ! r e - e n ' e

; ' a n t i t y

P r i c e ; ' a n t i t y

; ' a n t i t y

P r i c e

=

=


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Marginal revenue is t&e c&an%e intotal revenue from an additional unitsold.

45 "T5D


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*or competitive :rms? mar%inalrevenue equals t&e price of t&e %ood.

Ta'le 0 Total? Avera%e? and 4ar%inal 5evenuefor a Competitive *irm


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for a Competitive *irm

Copyright2004 South-Western

56*T 4AX4YAT6+ A+/ TLE


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56*T 4AX4YAT6+ A+/ TLEC64ETT;E *54 Q9 CQ5;E

T&e %oal of a competitive :rm is tomaximie pro:t.

T&is means t&at t&e :rm $ill $ant to

produce t&e quantity t&at maximiest&e dierence !et"een total revenueand total cost.

Ta'le < ro:t 4aximiation= A +umericalExample


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Example


*i%ure 0 ro:t 4aximiation for a Competitive *irm


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Copyright 2004 South-Western

Quantity+

Costs

and

Revenue

MC

ATC

AVC

MC1

Q1

MC

Q

The firm ma,imies

profit b( producingthe uantit( at whichmarginal cost eualsmarginal re/enue.

Q*A0

P MR1 MR P AR MR



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ro:t maximiation occurs at t&equantity $&ere marginal revenueequals marginal cost.



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Jhe!MR > MC in'reaseQ

Jhe!MR < MC de'reaseQ

Jhe!MR = MC ProHt isma%imi9e".

*i%ure < 4ar%inal Cost as t&e Competitive *irmsupply Curve


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pp y


Quantity+

Price

MC

ATC

AVC

P1

Q1

P

Q

This section of thefirm2s MCcur/e isalso the firm2s suppl(cur/e.

T&e *irms &ort-5un /ecision to &ut


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T&e *irm s &ort 5un /ecision to &ut/o$n

A s#utdo"nrefers to a s&ort-rundecision not to produce anyt&in%durin% a speci:c period of time

'ecause of current marketconditions.

$%itrefers to a lon%-run decision to

leave t&e market.



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T&e :rm considers its sunk costs$&en decidin% to exit? 'ut i%norest&em $&en decidin% $&et&er to s&ut

do$n. &unk costs are costs t&at &ave already

'een committed and cannot 'erecovered.



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T&e :rm s&uts do$n if t&e revenue it%ets from producin% is less t&an t&evaria'le cost of production.

&ut do$n ifTR ' C &ut do$n ifTRQ ' CQ

&ut do$n ifP ' AC

*i%ure 2 T&e Competitive *irms &ort 5un upplyCurve


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MC

Quantity

ATC

AVC

+

Costs

Firmshuts

down if

P3AVC

Firm2s short-runsuppl( cur/e

4f P5AVC,firm willcontinue to producein the short run.

4f P5ATC6 the firmwill continue toproduce at a profit.



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T&e portion of t&e mar%inal-costcurve t&at lies a'ove avera%evaria'le cost is t&e competitive :rms

s#ort*run supply curve.


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T&e *irms 9on%-5un /ecision to Exit or


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T&e *irm s 9on% 5un /ecision to Exit orEnter a 4arket

A :rm $ill enter t&e industry if suc&an action $ould 'e pro:ta'le. Enter ifTR + TC

Enter ifTRQ + TCQ Enter ifP + ATC

*i%ure J T&e Competitive *irms 9on%-5un upplyCurve


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MC = long-run S

Firme,its if

P 3ATC

Quantity

ATC

+

Costs

Firm2s long-runsuppl( cur/e

Firmenters ifP 5ATC

TLE Q9 CQ5;E + A


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C64ETT;E 4A5RET

T&e competitive :rms lon%-runsupply curve is t&e portion of itsmar%inal-cost curve t&at lies a'ove

avera%e total cost.

*i%ure J T&e Competitive *irms 9on%-5un upplyCurve


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MC

Quantity

ATC

+

Costs

Firm2s long-runsuppl( cur/e

TLE Q9 CQ5;E + A


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C64ETT;E 4A5RET

&ort-5un upply CurveT&e portion of its mar%inal cost curve

t&at lies a'ove avera%e varia'le cost.

9on%-5un upply CurveT&e mar%inal cost curve a'ove t&e

minimum point of its avera%e total costcurve.

*i%ure > ro:t as t&e Area 'et$een rice andAvera%e Total Cost


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(a) A ir! "ith Pro#its

Quantity+

Price

P AR MR

ATCMC

P

ATC

Q

7profit-ma,imiing uantit(8

"rofit

*i%ure > ro:t as t&e Area 'et$een rice andAvera%e Total Cost


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($) A ir! "ith %osses

Quantity+

Price

ATCMC

7loss-minimiing uantit(8

P AR MRP

ATC

Q

Loss

TLE Q9 CQ5;E + A


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C64ETT;E 4A5RET

4arket supply equals t&e sum of t&equantities supplied 'y t&e individual:rms in t&e market.

T&e &ort 5un= 4arket upply $it& a


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pp y*ixed +um'er of *irms

*or any %iven price? eac& :rmsupplies a quantity of output so t&atits mar%inal cost equals price.

T&e market supply curve re,ects t&eindividual :rms mar%inal costcurves.

*i%ure H 4arket upply $it& a *ixed +um'er of *irms


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(a) &ndividua' ir! Supp'y

Quantity (#ir!)+

Price

MC

1.++

1++

9.++

++

($) aret Supp'y

Quantity (!aret)+

Price

Suppl(

1.++

1++6+++

9.++

++6+++

T&e 9on% 5un= 4arket upply $it&


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% pp yEntry and Exit

*irms $ill enter or exit t&e marketuntil pro:t is driven to ero.

n t&e lon% run? price equals t&e

minimum of avera%e total cost. T&e lon%-run market supply curve is

&oriontal at t&is price.

*i%ure 1 4arket upply $it& Entry and Exit


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(a) ir!*s +ero-Pro#it Condition

Quantity (#ir!)+

Price

($) aret Supp'y

Quantity (!aret)

Price

+

P minimumATC

Suppl(

MC

ATC

T&e 9on% 5un= 4arket upply $it&


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Entry and Exit

At t&e end of t&e process of entryand exit? :rms t&at remain must 'emakin% ero economic pro:t.

T&e process of entry and exit endsonly $&en price and avera%e totalcost are driven to equality.

9on%-run equili'rium must &ave :rmsoperatin% at t&eir eVcient scale.

8&y /o Competitive *irms tay in


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Business f T&ey 4ake Yero ro:tP

ro:t equals total revenue minustotal cost.

Total cost includes all t&e opportunity

costs of t&e :rm. n t&e ero-pro:t equili'rium? t&e

:rms revenue compensates t&e

o$ners for t&e time and money t&eyexpend to keep t&e 'usiness %oin%.

A &ift in /emand in t&e &ort 5un and


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9on% 5un

An increase in demand raises priceand quantity in t&e s&ort run.

*irms earn pro:ts 'ecause price no$

exceeds avera%e total cost.

*i%ure An ncrease in /emand in t&e &ort 5unand 9on% 5un


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ir!

(a) &nitia' Condition

Quantity (#ir!)+

Price

aret

Quantity (!aret)

Price

+

D$emand6 1

SShort-run suppl(6 1

P1

ATC

Long-runsuppl(

P1

1Q

A

MC



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aretir!

($) Short-Run Response

Quantity (#ir!)+

Price

MC ATC"rofit

P1

Quantity (!aret)

Long-runsuppl(

Price

+

D1

D

P1

S1

P

Q1

A

Q

P %



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P1

ir!

(c) %ong-Run Response

Quantity (#ir!)+

Price

MC ATC

aret

Quantity (!aret)

Price

+

P1

P

Q1 Q

Long-runsuppl(

%

D1

D

S1

A

S

Q#

8&y t&e 9on%-5un upply Curve 4i%&t


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lope Qp$ard

ome resources used in productionmay 'e availa'le only in limitedquantities.

*irms may &ave di3erent costs.

8&y t&e 9on%-5un upply Curve 4i%&t


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lope Qp$ard

4ar%inal *irmT&e marginal ,rmis t&e :rm t&at $ould

exit t&e market if t&e price $ere any

lo$er.


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4onopoly


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8&ile a competitive :rm is apricetaker? a monopoly :rm is apricemaker.


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A :rm is considered a monopolyif . . . it is t&e sole seller of its product.

its product does not &ave closesu'stitutes.

8L 46+669E A5E


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8L 46+669E A5E

T&e fundamental cause of monopolyis !arriers to entry.

8L 46+669E A5E


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8L 46+669E A5E

Barriers to entry &ave t&ree sources= 6$ners&ip of a key resource.

T&e %overnment %ives a sin%le :rm t&e

exclusive ri%&t to produce some %ood. Costs of production make a sin%le

producer more eVcient t&an a lar%enum'er of producers.

4onopoly 5esources


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4onopoly 5esources

Alt&ou%& exclusive o$ners&ip of akey resource is a potential source ofmonopoly? in practice monopolies

rarely arise for t&is reason.

!overnment-Created 4onopolies


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!overnment Created 4onopolies

!overnments may restrict entry 'y%ivin% a sin%le :rm t&e exclusiveri%&t to sell a particular %ood in

certain markets.


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+atural 4onopolies


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+atural 4onopolies

An industry is a natural monopoly$&en a sin%le :rm can supply a %oodor service to an entire market at a

smaller cost t&an could t$o or more:rms.

+atural 4onopolies


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a u a o opo es

A natural monopolyarises $&ent&ere are economies of scale overt&e relevant ran%e of output.

*i%ure 0 Economies of cale as a Cause of 4onopoly


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Quantity o# ,utput

A/erage

total

cost

+

Cost

L68 46+669E 4ARE 56/QCT6+A+/ 5C+! /EC6+


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A+/ 5C+! /EC6+

4onopoly versus Competition 4onopoly

s t&e sole producer

*aces a do$n$ard-slopin% demand curve

s a price maker

5educes price to increase sales

Competitive *irm s one of many producers

*aces a &oriontal demand curve

s a price taker

ells as muc& or as little at same price

*i%ure < /emand Curves for Competitive and4onopoly *irms


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Quantity o# ,utput

$emand

(a) A Co!petitive ir!*s e!and Curve ($) A onopo'ist*s e!and Curve

+

Price

Quantity o# ,utput+

Price

$emand

A 4onopolys 5evenue


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p y

Total 5evenueP Q = TR

Avera%e 5evenue

TRQ = AR = P

4ar%inal 5evenue

TRQ = MR

Ta'le 0 A 4onopolys Total? Avera%e?and 4ar%inal 5evenue


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A 4onopolys 5evenue


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p y

A 4onopolys 4ar%inal 5evenue A monopolists mar%inal revenue is

al$ays less t#ant&e price of its %ood.

T&e demand curve is do$n$ard slopin%. 8&en a monopoly drops t&e price to sell onemore unit? t&e revenue received frompreviously sold units also decreases.

A 4onopolys 5evenue


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p y

A 4onopolys 4ar%inal 5evenue 8&en a monopoly increases t&e amount

it sells? it &as t$o e3ects on total

revenue (P

Q).T&e output e3ectSmore output is sold? so Qis &i%&er.

T&e price e3ectSprice falls? so Pis lo$er.

*i%ure 2 /emand and 4ar%inal-5evenue Curves fora 4onopoly


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Quantity o# Water

Price

9111+

;

?

&

#

1

+1

#

&

$emand

7a/erage

re/enue8

*arginal

re/enue

1 # & ? > = An Advertisin% !ame


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Copyright2001 South"esternho!son %earning

ar'$oro* s ecision

Advertise

Advertise

*arlboro gets 9#billion profit

amel gets 9#billion profit

amel gets 9?billion profit

*arlboro gets 9billion profit

amel gets 9

billion profit

*arlboro gets 9?billion profit

amel gets 9&

billion profit

*arlboro gets 9&billion profit

on*t Advertise

on*t

Advertise

Ca!e'*s

ecision


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8&y eople ometimes Cooperate


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*irms t&at care a'out future pro:ts$ill cooperate in repeated %amesrat&er t&an c&eatin% in a sin%le %ame

to ac&ieve a one-time %ain.

*i%ure 1 \ack and \ill 6li%opoly !ame


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:ac*s ecision

Se'' 40

;a''ons

Se'' 40 ;a''ons

Gac) gets

916>++ profit

Gill gets916>++ profit

Gill gets96+++ profit

Gac) gets

916?++ profit

Gill gets

916?++ profit

Gac) gets

96+++ profit

Gill gets

916


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Cooperation amon% oli%opolists isundesira'le from t&e standpoint ofsociety as a $&ole 'ecause it leads

toproduction t#at is too lo"andprices t#at are too #ig#.

5estraint of Trade and t&e Antitrust9a$s


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Antitrust la$s make it ille%al torestrain trade or attempt tomonopolie a market.

&erman Antitrust Act of 0G@ Clayton Act of 0G0J

Controversies over Antitrust olicy


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Antitrust policies sometimes may notallo$ 'usiness practices t&at &avepotentially positive e3ects=

5esale price maintenance redatory pricin%

Tyin%

Controversies over Antitrust olicy


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5esale rice 4aintenance (or fair trade) occurs $&en suppliers (like $&olesalers) requireretailers to c&ar%e a speci:c amount

redatory ricin%

occurs $&en a lar%e :rm 'e%ins to cut t&e priceof its product(s) $it& t&e intent of drivin% itscompetitor(s) out of t&e market

Tyin%

$&en a :rm o3ers t$o (or more) of its productsto%et&er at a sin%le price? rat&er t&an separately


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4onopolistic Competition



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mperfect competition refers to t&osemarket structures t&at fall 'et$eenperfect competition and puremonopoly.

T&e *our Types of 4arket tructure

.u!$er o# ir!s/


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Tap water able T

*onopol(7hapter 1?8

Do/els *o/ies

*onopolisticompetition7hapter 1=8

Tennis balls rude oil

Eligopol(7hapter 1>8

"erfect

heat *il)

ompetition7hapter 1&8

ype o# Products/

4denticalproducts$ifferentiatedproductsEnefirm Fewfirms

*an(firms



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Types of mperfectly Competitive4arkets Monopolistic Competition

4any :rms sellin% products t&at are similar'ut not identical.

6li%opoly 6nly a fe$ sellers? eac& o3erin% a similar or

identical product to t&e ot&ers.



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4arkets t&at &ave some features ofcompetition and some features ofmonopoly.



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Attri'utes of 4onopolisticCompetition 4any sellers

roduct di3erentiation *ree entry and exit



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4any ellersT&ere are many :rms competin% for t&e

same %roup of customers. roduct examples include 'ooks? C/s?

movies? computer %ames? restaurants? pianolessons? cookies? furniture? etc.



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roduct /i3erentiation Eac& :rm produces a product t&at is at

least slig#tly dierentfrom t&ose ofot&er :rms.

5at&er t&an 'ein% a price taker? eac&:rm faces a do"n"ard*sloping demandcurve.



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*ree Entry or Exit *irms can enter or exit t&e market

$it&out restriction.

T&e num'er of :rms in t&e marketad7usts until economic pro:ts areero.

C64ETT6+ 8TL

/**E5E+TATE/ 56/QCT


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T&e 4onopolistically Competitive*irm in t&e &ort 5un &ort-run economic pro:ts encoura%e

ne$ :rms to enter t#e market. T&is= ncreases t&e num'er of products o3ered.

5educes demand faced 'y :rms already int&e market.

ncum'ent :rms demand curves s&ift to t&eleft.

/emand for t&e incum'ent :rms productsfall? and t&eir pro:ts decline.

*i%ure 0 4onopolistic Competition in t&e &ort 5un

(a) ir! aes Pro#it


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Quantity+

Price

"rofit-ma,imiing

uantit(

"rice

$emand

MR

ATC

A/eragetotal cost

"rofit

MC

C64ETT6+ 8TL

/**E5E+TATE/ 56/QCT


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T&e 4onopolistically Competitive*irm in t&e &ort 5un &ort-run economic losses encoura%e

:rms to e%it t#e market. T&is= /ecreases t&e num'er of products o3ered.

ncreases demand faced 'y t&e remainin%:rms.

&ifts t&e remainin% :rms demand curvesto t&e ri%&t.

ncreases t&e remainin% :rms pro:ts.

*i%ure 0 4onopolistic Competitors in t&e &ort 5un

($) ir! aes %osses


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$emand

Quantity+

Price

"rice

Loss-minimiing

uantit(

A/eragetotal cost

MR

LossesATC

MC

T&e 9on%-5un Equili'rium


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*irms $ill enter and exit until t&e:rms are makin% exactly eroeconomic pro:ts.

*i%ure < A 4onopolistic Competitor in t&e 9on% 5un

Price


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Quantity+

$emandMR

ATCMC

"rofit-ma,imiing

uantit(

PATC

9on%-5un Equili'rium


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T$o C&aracteristics As in a monopoly? price exceeds

mar%inal cost. ro:t maximiation requires mar%inal

revenue to equal mar%inal cost.T&e do$n$ard-slopin% demand curve makes

mar%inal revenue less t&an price.

As in a competitive market? price equalsavera%e total cost.

*ree entry and exit drive economic pro:t toero.

4onopolistic versus erfectCompetition


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T&ere are t$o note$ort&y di3erences'et$een monopolistic and perfectcompetitionSexcess capacity andmarkup.



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Excess CapacityT&ere is no excess capacity in perfectcompetition in t&e lon% run.

*ree entry results in competitive :rms

producin% at t&e point $&ere avera%e totalcost is minimied? $&ic& is t&e eVcient scaleof t&e :rm.

T&ere is excess capacity in monopolisticcompetition in t&e lon% run.

n monopolistic competition? output is lesst&an t&e eVcient scale of perfect competition.

*i%ure 2 4onopolistic versus erfect Competition


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Quantity+

Price

$emand

(a) onopo'istica''y Co!petitive ir!

Quantity+

Price

P MC P MR7demand

cur/e8

($) Per#ect'y Co!petitive ir!

MCATC

MCATC

MR

@fficientscale

P

Cuantit(produced Cuantit( produced @fficient scale



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4arkup 6ver 4ar%inal Cost *or a competitive :rm? price equals

mar%inal cost.

*or a monopolistically competitive :rm?price exceeds mar%inal cost.

Because price exceeds mar%inal cost? anextra unit sold at t&e posted price

means more pro:t for t&emonopolistically competitive :rm.



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Quantity+

Price

$emand


Quantity+

Price

P MC P MR7demand

cur/e8


*ar)up

MCATC

MCATC

MR

*arginalcost

P

Cuantit(produced Cuantit( produced



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Price

$emand


Price

P MC P MR7demand

cur/e8


*ar)up

MCATC

MCATC

MR

*arginalcost

P

EE More Readings 2014

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